Right grievances but wrong solutions?
Not as dramatic as Tahrir Square in Cairo or street-to-street gun battles in Libya or on-going heroic uprisings elsewhere in the Middle East, the occupiers of Wall Street, now replicated all over the US and the world, could well effect a more profound shift in global politics than even the Arab Spring. Indeed, as the US economy and the EU, particularly the Eurozone, stagnates, and with rising unemployment and inflation, I think civil unrest in the West is likely to escalate for months to come, if not years. Could it even be the beginning of the end?
In view of this widespread feeling of anger, resentment and disillusionment, I thought it worth reviewing the financial meltdown of 2008, its causes, and its persistence. In particular, should we really blame the bankers, and should we pressure our governments into reigning back capitalism, as some of the ‘occupy’ protesters might want? I do think the broader sentiment of the occupiers is more sensible than that, and more nuanced and reflective of the complexity of problems we face. Much of the grievance seems real and justified (crony capitalism particularly involving the banking sector), but the proposed solutions could still be wrong. Emotive issues of inequality and social justice, for instance [“We are the 99%”], often lead to calls for more government involvement/intervention and less job creating private sector activity, which is seriously counterproductive. So, for the purposes of this post, let’s focus on why the 2008 meltdown happened and why its consequences are so persistent and manifest – and therefore, who should take the flak, the bankers or the government or us.
Though it all seems a bit murky, elusive, and getting more multifaceted by the minute with the Greek debt crisis, I will try to get down to the bare basics. First thing to acknowledge is that boom and bust is normal, and specifically, asset prices (stocks, property) will always, now and again, become inflated and deflated. Why? Because no one knows what is the ‘true’ or sustainable value of a particular firm’s stock or of a 3-bedroom house in Golders Green. As potential buyers we speculate, we try to get in on the action when things are cheap, and we get anxious and exuberant in equal measure when prices are rocketing. Many of us will remember the run up to late-2008 if we were trying to buy a house. It was the height of the bubble and yet more and more of us piled in, if not in exuberance, then at least not to get left behind. And of course the peak is only known in hindsight. Now put yourself in the shoes of stock market investors and traders, and you’ll see that it is much the same. As much as we may try to depict them as gamblers, they are fundamentally like us. They overstretched themselves in the financial markets like we overstretched ourselves in mortgages and credit card debt. Basically, we are all human with limited knowledge of things.
Now for that obscure thing called CDOs (Collateralised Debt Obligations), which are said to be at the heart of the 2008 crisis. Such financial innovations are now popularly denigrated as being a means for deceiving investors with sheer complexity. The CDOs we’re talking about here are those which take a bunch of mortgages (loans made by US mortgage lenders) lump them together into one bundle, then split them up into several tranches categorised by things like types and grades of repayment risk and priority of payments. These tranches are then sold on to other investors, each according to their taste - i.e. which tranches they prefer.
That said, we don’t need to know the nuts and bolts of CDO’s (thankfully) because the problem isn’t really the product itself or its complexity. New and complex products come out all the time and investors get used to them after a while. For instance, the very act of issuing or selling a company share was itself a completely unknown and perceptibly dangerous innovation many centuries ago. Indeed, innovation is the lifeblood of modern dynamic economies and by its nature it presents new challenges - i.e. instability. In any case, I also find it hard to believe that investors with billions at stake, including pension funds and global banks, didn’t know that these CDOs contained high risk sub-prime mortgages.
Rather, I think the truth of the crash lies in something else commentators have mentioned – irrational exuberance – though with the emphasis on exuberance, because it’s not really that irrational. Investors were willing to pay over the odds for these CDOs and much else besides, meaning also they were willing to tolerate higher risk, because this was a bull market and the bull had been running a head of steam for quite a few years. It’s no different to the ordinary property investor or hopeful homeowner willing to pay, or having to pay, over the odds for a house in 2008 – remember, you didn’t want to get left behind.
So markets go up and down, but what actually happened was more than that. It was a massive correction which led to a lasting economic slump and sharply rising unemployment. This needs explaining, and here we come to the role of us (society), government, and regulators. The thing is, catastrophe occurs when a lot of things go wrong at the same time, not when you have just one or two mistakes like sub-prime mortgages and exuberant finance. It’s like when you’re driving along and you momentarily take your eye off the road, reaching for the stereo or something. That’s mistake no.1 and you would often get away with it. But then suppose at the same time a nearby parked car has its door open right in your path. A collision may ensue. Yet even then, you could often swerve and avoid it so a collision is still not inevitable. Suppose then another parked car on the opposite side of the road opens its door at the same time as well, or perhaps there is a traffic island in the middle of the road preventing you from swerving! Now a collision is almost certain. Thus, catastrophe occurs when many things go wrong simultaneously.
Back to the economy then, what else went wrong in this perfect storm? Well, banks weren’t adequately regulated, and in particular retail banking (the bit that handles ordinary savings) wasn’t adequately protected or ring-fenced from investment banking where risky dealings are commonplace. Put another way, many of Britain’s biggest banks were stupid to put ordinary savings at risk by dealing in sub-prime mortgage backed securities (CDOs) and related debt, and not keeping them separate, while regulators were even more stupid in letting this happen. Quite bizarre then that while the FSA (Financial Services Authority) insists on checking-up on every single transaction, and every single client phone-call, in every small financial advisory firm that it grants a license to, it didn’t notice any of the daylight transgressions of the big banks. To clarify, I certainly wouldn’t call for more regulation, because the industry is far too overregulated anyway, preventing small players from entering the market and depriving small investors of investment advice and a decent range of affordable products. What was lacking was proper regulation, and proper enforcement of regulation, for the big banks.
Finally another failure was very much down to all of us. I say us rather than the government because we voted for Labour’s tax and spend policy, thinking well, more teachers and doctors and police, great. For a long time we probably didn’t see that it was old Labour, same as the one that was unelectable at the time of Neil Kinnock, because Tony Blair’s premiership gave it a reforming, pro-market, veneer. But underneath it was Gordon Brown presiding over tax credits reaching families earning £50,000 a year, skyrocketing public sector spending and employment, and the ‘discovery’ of a new phenomenon called child poverty (as distinct from parents’ poverty!). Ultimately, when you spend, spend, spend, you don’t have enough to deal with a rainy day. And the economy, with its private sector stifled, isn’t in a position to grow when it most needs to. Consequently today, we find ourselves amidst this great debate as to whether the government should cut its spending, continue as before, or whether it should increase spending instead, if the economy is to grow again. It is telling, however, that for the Labour party, spending on the public sector is to be increased in both good times and in bad. There is something seriously wrong with this approach. So this, in a nutshell, completes my thoughts on why the car crash of 2008 has had such a lasting impact. It is our fault really.
As an addendum, I also mean to say that it is not the bankers’ fault. All this populist banker bashing is ill-conceived I think, hence a couple of things are well worth clarifying. First, we must take the bad with the good. The same bankers were there during the prior decade-long boom and we didn’t complain then. We wanted to bank that, so to speak, but it seems we don’t want to take responsibility for the downside when it inevitably follows. Remember, both the boom and the bust come as a package – together. Second, contrary to much perception, we’re not helping out the banks. We bailed them out, not because we felt sorry for them, but we did it for ourselves. When banks collapse, and a run occurs, it is we who lose out, and we prevented that. I’m not a banker by the way. I’m just concerned that we’re getting the whole analysis wrong.
As a second addendum, admittedly I’ve only spoken about the UK circumstances on what is really a global issue. If we consider the US, two more important circumstances arise: (i) the rush to sell mortgages to people who clearly didn’t have the means (i.e. sub-prime), and (ii) some of the top bankers, so-called experts, and government, all in cahoots with each other. Let’s be clear, both of these are a failure of government, not really of capitalism per se. It was government that forced a financially irrational over-selling of mortgages, and it was government that succumbed to cosy relationships with bankers. It follows that what we need is less government involvement, more transparency, effective regulation, separation of government and corporations. In the less developed world, usually there is no distinction between government and big business (they do deals with each other and are often the same people), and look what it does to those countries – they have crippling levels of corruption and even armed rivalry for political power. So let us not ask for this. Let us not ask for governments to nationalise industries, or tax more and spend more. We need government to stay out of things and let the job-creating private sector function properly as it ought to.
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